Federal Reserve & Interest Rates

There are several mixed messages regarding whether or not the United States is facing a recession. We need to take an objective look at the economic factors, and understand that the data speaks for itself.

President George W. Bush recently made the statement that “Recent economic indications have become increasingly mixed.” His statement cannot be more accurate.

On the one hand, we have the sub-prime housing market slowing down the economy overall. Problems that stem from the decline of this market include tightened liquidity in the markets and bank lending ability, low consumer spending, increased unemployment in real estate, construction, and housing related retail. On the other hand, employment in most service-producing industries moved up, production in high tech industries increased modestly, and an increasing demand of exports has offset the higher cost of imports due to the declining dollar. The unemployment rate has held steady, as some businesses are profiting, and housing related business are slipping.

So, are we in a recession already? According to several economists, yes, we are already in a recession.

The dictionary definition of recession is “A period of slow economic growth,” according to Webster’s New World Finance and Investment Dictionary. If I use this definition, I would have to honestly admit that we are facing a recession right now. If you take a look at the minutes from the last FOMC meeting, there is plenty of economic slow down going on.

The chief economist of investment bank Merrill Lynch, David Rosenberg stated, “According to our analysis, this [recession] isn’t even a forecast any more but is a present day reality.”

Expert Martin Feldstein says that we need some serious tax cuts and further interest rate cuts by the FOMC. He isn’t convinced that we have hit a total ‘recession’ and more actions can help avoid it. He does, however, admit that recession is likely.

Whether you believe there is a recession happening now, or there will be one soon, doesn’t matter. The fact of the matter is that our economy is not as resilient as it once was, and it is starting to hit all of our wallets, bank accounts and investments. This year could take a turn, but it will take at least several months before there is enough positive economic data to restore the strength and growth rate of the U.S. economy.

The Federal reserve Board of Governors approved a new plan to “help promote the efficient dissemination of liquidity when the unsecured interbank markets are under stress.” This arrangement, called the Term Auction Facility (TAF), along with Foreign Exchange swap lines, is set to take effect Monday, December 17th.

“Each TAF auction will be for a fixed amount, with the rate determined by the auction process (subject to a minimum bid rate). The first TAF auction of $20 billion is scheduled for Monday, December 17, with settlement on Thursday, December 20; this auction will provide 28-day term funds, maturing Thursday, January 17, 2008. The second auction of up to $20 billion is scheduled for Thursday, December 20, with settlement on Thursday, December 27; this auction will provide 35-day funds, maturing Thursday, January 31, 2008.”

According to the press release, third and fourth auctions are planned for mid January and January 28, 2008. Bids will be submitted by depositories through their local Reserve Banks. The minimum bid rate is to be figured at the OIS, overnight indexed swap, rate relative to the maturity of the credit being auctioned.

The Bank of Canada, the Bank of England, the Swiss National Bank, and the European Central Bank are all involved in the effort to address the elevated pressures in short-term funding markets. The U.S. Federal Reserve has arranged for FOREX swap lines with the European Central Bank and the Swiss National Bank. Basically, securities can be used as collateral for liquid funds for lending purposes.

The swap lines are approved for six months, tentatively.

The mortgage problem is expected to only get worse. Another 500,000-700,000 foreclosures are anticipated. If the value of homes drops more than 30%, there could be more than 20 million homeowners with negative equity.

Recession is still a looming fear. It is time to buckle down on spending, pay back as much debt as possible, and hold on tight. It is going to be a bumpy ride in 2008.

The November employment data is in. Overall, the information is positive, which dampens hopes for rate cuts on Tuesday at the next Federal Open Market Committee.

According to the Labor Department payroll report there were 94,000 jobs added during the month of November. A good portion of the job increase was in retail, which contributed 24,000 jobs (understandable for the common holiday staff increase in stores). Unemployment was expected to rise, but instead held at 4.7%. Hourly earnings increased by 0.5%, which is higher than expected.

On Wall Street, the Dow was up 5.69 points at the week’s close. The Dow Jones Transportation Average rose 1.81%. U.S. supplies of gasoline are looking good, and the price per barrel of crude oil lowered by $1.95. The 10-year Treasury note was down 9/32 yielding 4.051%.

Investors are pausing for the Fed to decide on cutting rates Tuesday. Positive employment data and some nice performance in the stock market might make the case for a need to cut rates a little less convincing. With the recent oil pricing relief, the outlook on inflation might more positive. There is no clear way to tell whether or not the FOMC is going to risk inflation increases by cutting rates again. The markets have been doing well for almost two weeks, and investor confidence is rising.

The positive economic data might convince the Fed to keep the rates where they are. There is always the option of cutting a quarter percentage point. A half-point cut may not be necessary, if any cut is necessary at all. The Fed might decide on a modest rate reduction. If not, they will probably wait until the end of January to make any further moves. The economy seems to be holding up since the October rate cut.

Concerns about economic slow down have not completely subsided, but it is good to hear some positive news. Recession is becoming less and less likely as time goes on. Is it possible that the cuts made this year have been enough to keep the economy from plummeting? The goal of the Federal Reserve was to at least forestall the negative affects of sub-prime mortgage lending, and a possible credit crunch. Downside risks in lending and inflation continue to be a concern, but reports this week may ease those concerns.

The Fed might make a modest cut in rates just one more time this year to ensure that things continue to go well. There is also a chance that the previous cuts might have done the trick. Wall street will be waiting for Tuesday’s decision.